Expanding your business to include international trade can require the use of letters of credit or guarantee to ensure payment after delivery. While also used in some domestic transactions to force payment, without such letters, companies can face a difficult battle receiving payment for a delivered shipment due to differences in collection laws. The differences between the two matter depending on whether you are the shipper or receiver in the transaction.

Letter of Credit

Selling a product to a customer is often a leap of faith. Short of requesting cash on delivery or prepayment, you are trusting that your customer will pay as promised. Requesting a letter of credit from your customer requires that he go to a bank and receive a letter stating that the bank will pay after you provide the letter and proof of delivery. A letter of credit eliminates any financial risk to the seller because the payment comes from the third-party bank not the purchaser.

Letter of Guarantee

A letter of guarantee acts like a letter of credit with one important distinction -- the letter of guarantee pays either party if the other does not fulfill the transaction's requirements. For example, if you pay your supplier for a shipment before delivery and do not receive your product, and you asked the supplier for a letter of guarantee before sending payment, the bank must reimburse you for the undelivered product. The letter of guarantee entitles you to reimbursement without having to go to court if the shipper is unable to produce proof of delivery.

Risk

The level of risk for the provider of the letter differs. A letter of guarantee is typically not backed by any security that the financial institution can take if it has to pay a claim. For example, a performance bond is a letter of guarantee. Obtaining a bond requires paying the bond issuer for the bond, and the issuer takes the risk that you will perform as promised. Obtaining a letter of credit requires paying the value of the contract to the financial institution upfront or providing security for the letter. The provider has a larger amount of risk with a letter of guarantee than a letter of credit.

Considerations

Many municipalities require service providers to obtain a bond before working for customers. Other reasons you may need a letter of credit or letter of guarantee include transaction requirements from the other party and protecting your own interests. In addition, a performance bond can assist you with winning new contracts because it provides security to the other party, according to the Canadian Imperial Bank of Commerce (CIBC). A letter of credit can free up your business's cash flow by preventing the upfront payment required by some suppliers. Banks and other financial institutions provide letters of credit and some letters of guarantee. However, if your company needs a performance bond, talk to your insurance provider if your bank does not provide them.